Taking Advantage of Dividends?

As our analysts look at the stock markets around the world, a theme emerges-good companies have been beaten up as much as bad companies. In other words, this recession has affected both good companies and bad companies in their valuations. However, even in these bad times many good companies are still profitable and continue to pay part of that profit back to their shareholders in the form of dividends. While we wait for the economy to improve, dividend-paying stocks and managed portfolios might make good sense for many investors. Let's explore what dividends are and how you can make them work for you.

What are Dividends?

A dividend is a cash payment from a company's earnings, announced by a company's board of directors and distributed among stockholders. In other words, dividends are an investor's share of a company's profits as a part owner of the company.

When a company earns profits from its operations, management can do one of two things with them:

• It can reinvest them in the company in the hope of creating more earnings and thus further stock appreciation.
• It can distribute a portion of the profits to shareholders in the form of dividends.

One advantage to including dividend-paying stocks in your portfolio is that dividend income is tax preferred over other types of income such as interest earnings. For this reason, many investors who now need to live on the income from their portfolio will decide to increase the dividend earnings from their portfolio.

Dividends are straightforward

By choosing to pay dividends, management is essentially conceding that profits from their operations are better off being distributed to the shareholders than being put back into the company. In other words, they believe that reinvesting profits to try to achieve further growth will not offer the shareholder as high a return as a distribution in the form of dividends.

Another motivation for a company to pay dividends is that a steadily increasing dividend payout is viewed as a strong indication of a company's continuing success. The wonderful thing about dividends is that they cannot be falsified. They are paid or not paid, increased or not increased.

Expected growth rates can also be unreliable at times. A company can talk about impressive growth opportunities that will pay off in several years, but there are no guarantees that it will make the most of its reinvested earnings. When a company's robust plans for the future (which influence its share price today) fail to materialize, your portfolio will likely be negatively affected.

However, you may rest assured that no accountant can restate dividends and take back your dividend cheque. Moreover, dividends cannot be squandered by the company on business expansions that fail to thrive. The dividends you receive from your stocks are 100 percent yours. You can use them to do whatever you want, such as pay down your mortgage, spend them, or re-invest elsewhere.

How can you invest to receive dividends?

Investors looking for exposure to the growth potential of the equity market, combined with the safety of the (moderately) fixed income provided by dividends, should consider adding stocks with high-dividend yields to their portfolio. A portfolio with dividend-paying stocks is less likely to experience price volatility than a growth-stock portfolio.

You can increase the dividend-producing holdings in your portfolio in two ways:

• Build a portfolio of shares of large companies that have a dividend yield in their stock. The pros are the flexibility of the holdings and a generally lower fee for management of the portfolio. The cons are that they are riskier and take time and expertise to manage. It is also hard to properly diversify your portfolio with a limited amount of capital. If you only own a few dividend paying stocks in your total portfolio, there is always the risk of several of those companies cutting their dividend or stopping it completely.
• You can invest in a dividend mutual fund or a dividend-based managed investment account. The pros of this approach are the opposite of individual holdings. They tend to have a lower risk profile, are expertly managed, your portfolio risk is spread among many dividend paying companies and they do not require much time on your part. There is, however, a fee for this service but for many investors the fee is worth the diversification and expert management.

Conclusion

Dividend-producing investments and dividend focused managed accounts can be excellent vehicles for those who want to lower their risk level while generating income that is tax preferred. As we get older and count on our portfolios as a means of supplementing our income, dividends could be the answer. If you would like to explore how a dividend portfolio could help you, please call our office for an appointment.